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Fittingly Foolish

Last week – on April Fools’ Day – the SEC announced this [1] administrative action against KBR Inc.

It was fitting because the action was foolish.

In the words of the SEC:

“The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, amended the Exchange Act by adding Section 21F, “Whistleblower Incentives and Protection.” The congressional purpose underlying these provisions was “to encourage whistleblowers to report possible violations of the securities laws by providing financial incentives, prohibiting employment-related retaliation, and providing various confidentiality guarantees.” […]

To fulfill this congressional purpose, the Commission adopted Rule 21F-17, which provides in relevant part: (a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.”

As to KBR, the SEC stated:

“As part of its compliance program, KBR regularly receives complaints and allegations from its employees of potential illegal or unethical conduct by KBR or its employees, including allegations of potential violations of the federal securities laws. KBR’s practice is to conduct internal investigations of these allegations. KBR investigators typically interview KBR employees (including the employees who originally lodged the complaint or allegation) as part of the internal investigations.

Prior to the promulgation of Rule 21F-17 and continuing into the time that Rule 21F-17 has been in effect, KBR has used a form confidentiality statement as part of these internal investigations. Although use of the form confidentiality statement is not required by KBR policy, the statement is included as an enclosure to the KBR Code of Business Conduct Investigation Procedures manual, and KBR investigators have had witnesses sign the statement at the start of an interview.

The form confidentiality statement that KBR has used before and since the SEC adopted Rule 21F-17 requires witnesses to agree to the following provisions: I understand that in order to protect the integrity of this review, I am prohibited from discussing any particulars regarding this interview and the subject matter discussed during the interview, without the prior authorization of the Law Department. I understand that the unauthorized disclosure of information may be grounds for disciplinary action up to and including termination of employment.”

And now for the foolish part.  The SEC specifically stated:

“Though the Commission is unaware of any instances in which (i) a KBR employee was in fact prevented from communicating directly with Commission Staff about potential securities law violations, or (ii) KBR took action to enforce the form confidentiality agreement or otherwise prevent such communications, the language found in the form confidentiality statement impedes such communications by prohibiting employees from discussing the substance of their interview without clearance from KBR’s law department under penalty of disciplinary action including termination of employment. This language undermines the purpose of Section 21F and Rule 21F-17(a), which is to “encourage[e] individuals to report to the Commission.”

Based on the above, the SEC found that KBR violated Rule 21F-17.

Without admitting or denying the SEC’s findings, KBR agreed to pay a civil monetary penalty of $130,000.

A far more prudent approach would have been for the SEC to issue a Section 21(a) Report of Investigation (see here [2]).

The supreme irony of the SEC’s enforcement action?

While faulting KBR for its non-existent, theoretical muzzling of individuals, the SEC routinely muzzles corporate defendants in SEC enforcement actions.

For instance, the recent PBSJ deferred prosecution agreement [3] with the SEC stated:

“Respondent agrees not to take any action or to make or permit any public statement through present or future attorneys, employees, agents, or other persons authorized to speak for it, except in legal proceedings in which the Commission is not a party in litigation or otherwise, denying, directly or indirectly, any aspect of this Agreement or creating the impression that the statements in [the Statement of Facts” are without factual basis. […] Prior to issuing a press release concerning this Agreement, the Respondent agrees to have the text of the release approved by the staff of the Division.”

The Ralph Lauren non-prosecution agreement [4] and the Tenaris deferred prosecution agreement [5] contained the same muzzle clauses.